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Saturday, December 3, 2011

Rupee which was once trading at 44 levels against the US dollar suddenly zoomed to 52 levels and even breached that.

A discerning question arises why rupee is weakening like this?

Rupee Depreciation

There are many reasons for depreciating rupee but things begin with the financial crisis in USA and Europe.

Due to slowdown in USA and sovereign debt-crisis in Europe, Indian exports to these areas got hampered. We know that dollar being the reserve currency exports earn dollars while imports cost dollars.

Lesser exports meant lesser dollar inflows in the nation. And according to the ‘Demand and Supply rule’ lesser dollar inflows weakened the rupee against the dollar- that means one has to pay more rupees for a dollar.

Apart from the falling exports, capital flows from the USA and Europe to India also dwindled. This further helped dollar to grow strong against the Indian rupee.

FII’s were forced to sell in the Indian capital market owing to redemption pressure by retail and institutional clients abroad. This led into the outflow of dollars from India and helped appreciation of the dollar.

India fulfills 70% of its oil requirement through imports and payment for this is done in dollars.

When rupee started depreciating against the dollar, oil-imports became dearer.

Our oil companies out of fear that rupee shall depreciate further,went on dollar buying spree which raised the demand for dollar in the forex market, and rupee fell further.

All this turned into a downward spiral for rupee and rupee crossed the 52 levels.

But the thing to note is that rupee was not the only currency to depreciate against the dollar but many other currencies too have been depreciated. The sovereign debt crisis in Europe led to shifting of the capital from Europe to USA resulting in appreciating dollar.

Why RBI did not intervene?

RBI could have stopped the wakening rupee by selling dollars from its foreign exchange corpus but intervention from the RBI came late.

RBI can’t be blamed for the late intervention as India’s foreign reserves mostly comprise borrowed funds and the same can’t be used indiscriminately to prop the falling rupee against the dollar.

As India attracts more portfolio investment than direct investment and the same could be withdrawn immediately, RBI was hesitating to divest its foreign reserve to arrest the rupee depreciation.

Ultimately what RBI did to arrest the rupee fall?

Though late but RBI came up with manysignificant steps to stop the falling rupee. It directly sold dollars to the OMC (oil marketing companies). Earlier OMC’s would buy dollars from the open market and their buying would help dollar to surge high. OMC’s directly buying dollars from RBI avoided the rupee’s depreciation.

RBI also eased the overseas borrowing and raised the interest rates on dollar deposits so that more dollars could come-in to make rupee stronger.